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Time to Choose Your Inflation Adventure with Velocity and Money
We have CPI coming up in a few days, but M2 came out recently and it is worth commenting about, so let me drop some thoughts about the state of money and velocity right now and the context we are operating in.
M2 grew 0.88% in February, causing the y/y change to rise to 4.88% (quarterly, however, it is 6.65% annualized). I saw somebody recently observe that money growth was about 6ish back before COVID, so this level is not very worrisome to that pundit. I think that’s wrong – not that this level is worrisome in the big picture, but the trend is bad and the current level is actually not consistent with low and stable inflation as it was prior to the late twenty-‘teens.
Before we get to that, let’s review the state of play for money velocity. Remember when velocity plunged early in COVID, and people said inflation wouldn’t happen because the transmission mechanism was broken? That comment was so funny it made me blow milk out of my nose, even though I wasn’t drinking milk. It was entirely an artifact of the different time frames over which the money supply was changing, compared to the time frames required for prices and output to change. MV=PQ, and M was changing suddenly. Since GDP can’t suddenly change 20%, money velocity became the capacitor that held the excess charge which slowly bled into prices. In my podcast, and occasionally in this blog, the image I shared was of a car rapidly accelerating away from a trailer hitched to it by a spring. At first, inertia keeps the trailer from traveling as fast as the car, and the spring stretches. Once the car stops accelerating, though, the spring compresses and the trailer catches up. The illustration below is courtesy of Lovart.ai.
So where are we? Here is the US monetary system over the 2019-2025 period showing total growth from December 2019. The x-axis shows the total percentage growth in money as a percentage of real output (M/Q). The y-axis shows the total change in the price level. Now, I have to point out that when I was talking about this, in 2021 or 2022, we were very far away from the diagonal line showing where the two changes are equal. And I said we would be going back to the line, and we went back to the line. People really ought to listen to me more.
The other way to look at this is that velocity is back almost to where it was prior to COVID.
So is there any problem here? Velocity is back to where it was, but if it’s stable and money is growing at 4.9% y/y, then P+Q grows at 4.9%, so 2% inflation with 3% growth…sounds pretty good.
This is where we review the “but 6% worked!” argument.
You can see from the chart that yes, since the late 1990s M2 grew at 5-10% and we never had much of an inflation problem. Why now? Well, during that period velocity was steadily declining – and that is the only way that you can sustain 6% money growth with 3% real economic growth and get 2% inflation. The question, then, was why velocity was declining. Remember, some people think this is a trend, because they don’t really understand what drives velocity. During that period, interest rates steadily declined. This was also a period of increasing globalization and a demographic dividend (more workers relative to the aged). Now, whether the interest rates declined because of those trends because both trends were disinflationary, or if interest rates declined because of a dovish Fed and they only got lucky because of those trends…I don’t know. But the point is that the largest driver of lower money velocity during that period was lower interest rates.
And interest rates are now approximately fair. Some people think they’re too low with inflation too hot, some people think they’re too high with economic growth seeming to slow, but let’s just say they’re not 300bps wrong at this point. Here is our velocity model. With lots of crazy volatility, it has velocity pretty close to on-target. Here’s the problem: the last time prior to COVID were as high as they are now (I’m looking at 5y Treasuries), it was also prior to the Global Financial Crisis and the regime of interest rate repression. Back in 2007, 5y rates were this high, and money velocity was about 2.0, some 40% higher than here. What is holding velocity down right now in our model is a very high level of economic policy uncertainty, which causes people to hold more cash than they otherwise would given the level of interest rates. Thanks to the war between the President and his allies on one side, and the minority party on the other side, not to mention the Iran war, there is a lot of uncertainty right now and that is causing people to conserve cash.
It won’t always be that way, but with M2 growing near 5%…it really needs to be that way. By the way, the money growth situation is a bit worse than it looks, too: there has in the last couple years been a fairly dramatic rise in the amount of non-M2 money that is growing in defi/crypto space. Bitcoin isn’t money, but stablecoins are very much like money. The scale of the Stablecoin money supply is small compared to the ‘off-chain’ money supply, but it is starting to get large enough to matter. Anyway, we know the sign of that growth, and it’s a big fat plus.
So no, 6% is not a stable rate of money growth going forward from here. This is not the early 2000s. It is not the 1990s. If we could manage to just have 6% growth, then we’re probably going to end up being in the mid-to-high-3s on inflation, and that’s tolerable. But if that’s the midpoint of money growth, then mid-to-high-3s is the midpoint on inflation with some periods a little below that and some periods a little above that.
Economies adapt, and an economy can work fine at 4-5% inflation or even higher as long as it is stable. But 4% inflation feels different than 2% inflation, and the economy will work differently in that sort of regime. Businesses will be more likely to pass through cost increases rather than absorb what they think are short-term variations (see “How Expecting Inflation Un-anchors Manufacturers’ Pricing Strategy”). Equilibrium equity prices are lower. Menu costs and search costs go up. And so on. We may already be seeing some of these long-term structural changes. The Fed just published a FEDS Notes entitled “Is the Inflation Process in Advanced Economies Different After the Pandemic?” The short answer? Yes it is. The question is, are we on track to get the inflation process back to the way it used to be? And the answer there appears at this juncture to be: no.
Inflation Guy’s CPI Summary (January 2026)
Let’s start by setting the context for today’s CPI number.
A couple of months ago, we missed a CPI because of the shutdown. The BLS simply didn’t have any data to calculate the October 2025 CPI. That wasn’t the real problem. The real problem was that the BLS’s handbook of methods more or less forced it, in calculating the November CPI index, to assume unchanged prices for October for some large categories – in particular, rents. This caused a large, illusory decline in y/y inflation figures. Importantly, this was also temporary – there has been some catch-up but the big one comes in a few months when the OER rent survey rotation will cause a large offsetting jump in that category, exactly six months after the illusory dip. Until then, inflation numbers will be more difficult to interpret and the year-over-year numbers will be simply wrong. So when you read that today’s figure resulted in the “smallest y/y change in core inflation since 2021, and consistent with the Fed reaching its target” – that’s just wrong. The true core y/y number is roughly 0.25%-0.3% higher than what printed today. The CPI ‘fixings’ market is currently pricing headline CPI y/y to rise to 2.82% four months from now, and that isn’t because of a coming rebound in energy prices.
I guess what I am saying is this:
Ladies and gentlemen, please take your seats. We will be experiencing some mild turbulence.
January, in general, is already a difficult month in CPI land because of the tendency for vendors of products and services to offer discounts in December and then implement annual price increases in January. But those price increases are not systematic, which means they are difficult to seasonally-adjust for. Ergo, January misses are rather the norm.
So with that context, the consensus estimates for today’s number were for +0.27% m/m on the headline CPI, and +0.31% on core. Some prognosticators were quite a bit higher than that – I think Barclays expected +0.39% on core CPI. The question was basically whether there is still any tariff increase that needs to be passed through; if so then January is a good time to do it. That didn’t really happen. The actual print was +0.17% on headline and +0.30% on core.
The miss on headline happened because while gasoline prices actually rose in January, the average price in January was lower than the average price in December – because in December, gasoline prices dropped sharply. While Jan 31 gas versus Dec 31 gas was $2.87 vs $2.833 (source AAA), January 1 vs December 1 was $2.83 vs $2.998. So, even though gasoline prices rose over the course of January compared to the end of December, that’s now how the BLS samples prices.
Be that as it may, core inflation was pretty close to target. One way to look at it is that y/y Core CPI, at 2.5%, is the lowest since March 2021. Another way to look at it is that the m/m Core was the third highest in the last year, and annualizes to 3.6%. So is it ‘mission accomplished’ for the Fed? Erm, nothing in the chart below tells me inflation is trending gently back to 2%. You?
The core number was actually flattered by a large drop in used car prices, -1.84% m/m. Used car prices actually rose in January, but less than the seasonal norm so that resulted in the large drop and that caused a meaningful drag. (Let’s not get in the habit of just dropping everything that doesn’t fit the narrative, though.) Anyway, core goods as a whole dropped to 1.1% y/y from 1.4%, while core services eased to 2.9% y/y from 3.0%.
While core goods fell more than expected because of that Used Cars number, it’s not surprising that it is moderating some. The question isn’t whether core goods prices will keep accelerating to 3% or 4%; the question is whether it stays positive, or slips back to the negative range it inhabited for many years. That’s an important story even though core goods is only 20% of the CPI. Until now it has been a ‘tariffs’ story, but going forward it’s an ‘onshoring’ story. My contention is that we should not expect a return to the persistent goods deflation that flattered CPI for a generation thanks to offshoring of manufacturing to low-labor-cost countries, because the flow is reversing. That is the story to watch, but it isn’t January 2026’s story.
While we are talking about autos, I’ll note that New Cars showed a small increase. I wonder (and I don’t have a strong forecast here) what the changes in car sales composition now that electric vehicles are no longer being pushed by the executive branch. Obviously non-electric cars are cheaper, so if we had a real-time measure of the average sales price of a car it would probably fall as consumers go back to buying cars they want instead of cars that look cheaper because of tax breaks. I don’t know though how much actual sales will change (auto production will certainly change as carmakers no longer have to check the box by making a certain number of cars that were hard to sell), and I don’t know how detailed the BLS survey is and whether it takes into account fleet composition. I guess we know that if there’s any effect, the sign should be negative. I suspect it is a small effect.
Turning to rents, as we do: Owners Equivalent Rent was +0.22% versus +0.31% last month. Rent of Primary Residence was +0.25% vs +0.27% last month. The chart below shows the m/m changes in OER… except that it does not show the 0 for October. There’s clearly a deceleration here, but my model says it should be flattening out right about at this level. Also not January 2026’s story, but it will be 2026’s story.
There was a small decline, -0.15% m/m, in Medicinal Drugs. Some folks had been eagerly waiting for that to show a large drop, thanks partly to the Trump Administration’s efforts to force drug manufacturers to align prices in the US market with prices in the ex-US market. There is not yet any discernable trend. Potentially more impactful is the Trump RX initiative, which by bringing transparency and cutting out the middleman in the really-effed-up consumer pharmaceuticals pipeline (dominated by three big wholesalers and three big pharmacy benefit managers, each of which is highly opaque about pricing) could well cause a significant decline in consumer-paid drug prices. But…remember that when those drugs are paid for by the insurance company, it isn’t a consumer expense and only shows up indirectly in the CPI. Yeah, that makes my head spin also. Bottom line: pharmaceutical prices are likely to decline some for consumers, but we just aren’t really sure where that will show up in the CPI and how soon it will happen.
The best news in the report today is the continued deceleration in core-services-ex-rents (‘Supercore’), which decelerated even with Airfares being +6.5% m/m.
Psych! You fell victim to one of the classic blunders! This is again a y/y figure that is flattered by the lack of October data. On a m/m basis, supercore had the biggest jump in a year, +0.59% (SA). Still, I think this is decelerating along with median wages deceleration. Of course, all of that data is messy right now as well, but the spread of median wages over median inflation remains right around 1%.
There is some early evidence that the downward slide in wages might be leveling off; if it does, that will limit how fast supercore can moderate. There are also some cost pressures in insurance markets that are probably going to show up in the next 6 months or so. But that’s not January 2026’s story.
The story in January 2026 is that the waters remain muddied by the government-shutdown-induced gap. The current y/y figures are all flattered by that event, and exaggerate how good the inflation picture is. That’s how the Administration can trumpet victory while the reality on the ground is that inflation is not converging to trend.
I’m working on the assumption that the Fed knows this, and the combination of core inflation that seems steady around 3.5% (abstracting from the shutdown gap), better-than-expected labor market indicators, and a distinct animus among current Fed leadership towards the President means that there’s no reason to expect an adjustment in overnight rates any time soon. Frankly, I think the argument is better for a rate increase than a rate decrease. On the other hand, rents do appear to be continuing to decelerate even if we ignore the October gap. My model says that isn’t going to continue, and even if I’m wrong I’m likely to be closer than the folks calling for deflation in housing. And moderation in Supercore is encouraging, even if – again – I don’t think that continues to the point the Fed needs it to be. Core goods inflation appears to have peaked, and the question is whether we go back to core goods deflation or not.
In each of these cases, my modeling suggests that the current level of median inflation of around 3.5% (ex-gap) is likely to end up being an equilibrium-ish level. But it isn’t ridiculous to look at the current trends and see good news on inflation. Either way, there’s not a Fed ease coming imminently. But if those trends continue until Warsh is confirmed and becomes Fed Chairman, there could be a rate cut later in the year.
But that’s not January 2026’s story.
Inflation Guy’s CPI Summary (December 2025)
Let’s start this month by remembering the absolute dumpster-fire that was last month’s CPI. The number for November was patently ridiculous on its face, and it took mere minutes to realize that the BLS was showing 2-month changes for what were essentially one-month changes:
“Because what it looks like is that for many series the BLS didn’t calculate a two-month change based on the current price level – it looks like, especially for housing, they assumed October’s change was zero so that the two-month change reported for this month was actually a one-month change spread over two months. For example, even with the low Owners’ Equivalent Rent print in September, the y/y figure was 3.76%, so about 0.31% per month. The BLS tells us that the two-month change in OER was +0.27%. That looks more than a little suspicious to me.”
That in fact was what had happened. The BLS has clearly spelled-out procedures for what happens when they cannot collect a price. If they can collect the price for other similar items, they impute the data for the uncollected price by ‘adjacent cell imputation.’ Happens all the time, and has happened more since there have been fewer data collectors, and that has upset a lot of people…but it’s no big deal. What happens less often is that the BLS can collect no similar price, or they don’t have a statistically-significant sample; in that case the BLS procedures call for the prior price to be carried forward and then the price gets naturally corrected the next time it can be gathered. I’ll talk more about this in a week or two, but if the item was generally rising in price that unchanged estimate for monthly price change will be a little low in the first month and a little high in the second month. If the item was generally getting cheaper, you’ll be a little high and then a little low when you catch up. But that’s better than taking a wild unscientific guess.
But normally, that happens for tiny categories. In this case, since no prices were collected, the BLS realized that its procedures called for carryforward pricing. After the data were released, they were very transparent about the fact that this caused understatement in the CPI, and that while most categories will be corrected by normal sampling in a month or two, the rent and OER samples will take about six months to correct because of the way those samples use overlapping six-month survey panels. You don’t need to worry about the fine details here, but to realize that the October number is missing, the November number is garbage, and the year/year numbers won’t be “right” for a while.
Ergo, take everything in today’s number, and all the charts, with a grain of salt.
A little side note is that the BLS was able to collect some data for November, when there was historical data available, so some of the series are complete. And some series have a dash (“-“) for November. Bloomberg simply omits October for those series. The practical consequence is that this is a massive mess for anyone who has built spreadsheets based on fairly normal assumptions about data structure! And it will be for a while. Anyway, on to today’s number.
Over the last month, inflation markets have been little changed.
They’re actually even more unchanged than that looks like, because the apparent rise in short-term inflation expectations is a quirk of the fact that every day, the window covered by a 1-year swap rolls forward one day, and as it turns out the day that it loses on the front end is a day when the NSA CPI was declining sharply thanks to the garbage report we just mentioned. So, the new 1-year swap has less of that garbage dragging the y/y rate down, and so it rises slightly. The net result is that inflation expectations at the front end are not really rising.
The expectations for the December CPI were for +0.31% on the seasonally-adjusted headline, with +0.32% on Core. These are even more guessy guesses than normal, since economists had to figure which categories might jump back and by how much. The actual CPI came in at +0.307% (SA) on headline CPI, and +0.239% on Core CPI. We will ignore the y/y rates for now. If we take those numbers at face value, it would annualize to 2.9% on Core CPI and 3.75% on headline CPI. That doesn’t seem wildly off, with the obvious caveat that annualizing a one-month change is stupid. Sorry.
Now, the Median CPI is going to be a snap-back sort of month. I think. The median category appears to me to be one of the regional OERs, so the actual number will depend on the seasonal adjustment the Cleveland Fed applies to that subindex. And I don’t know what the Cleveland Fed did for their last data point so they may be jumping off differently than I did. But any way you slice it, we’re going to be around 0.30-0.35% for median.
This is right about where the trend was prior to September. A word on September: while it is convenient to think that September was the ‘last good data point’ we had before the shutdown, remember that month had an outlier Owners’ Equivalent Rent number (0.14%, vs a series of 0.28%-0.40% that happened in the year prior to that) that we expected to rebound in the next month. We never saw the rebound. Median CPI was also affected by that, and so the last truly normal number was August. The upshot of it is that there may be some continued deceleration in median CPI, but it isn’t clear at all.
Core goods as of this month were +1.42% y/y. They look to be leveling off a bit, and it may be that the bump from tariffs (which, contrary to economic theory but in keeping with the way it really works, got bled into prices over a period of time rather than all at once) is petering out. Too early to tell, and part of this leveling out is due to soft Used Cars data in this month’s release. Core Services, mostly housing, continues to decelerate but see all of the caveats about rents.
And yes, rents went back to doing what they had been doing. Primary Rents were +0.26% m/m, and Owners’ Equivalent Rent was +0.31% m/m. So, yeah: that dip in OER in September was a mirage, and we’re still running at 3-4% in rents although the one-month BLS blip makes it appear that we’re still decelerating. I am not sure that’s really true.
Speaking of rents, Barclays put out a great piece earlier this week. It’s called “Apples and oranges in the CPI basket: Why market rent gauges mislead on shelter,” and if you have access to it you should read it. If you do not have access to it, you can just read my articles from the last few years. Seriously, though – it’s a very good piece and I’ll talk about it more in a week or so. But here are two of my favorite exhibits from their writeup.
Since 90% or so of rents are continuing rents, and all of the high-frequency rent indicators are recording new rents…can you see why there’s a problem?
That’s why a few years ago I migrated my model for rents to be based on a bottom-up estimate of what landlord costs were doing. Here is that model with the updated Primary Rents.
Normally, the Enduring Model has more lead time, but since part of it relies on PPI data that haven’t been released since September (and which is coming out tomorrow), the look forward is shorter than normal. Still, it says the same thing I’m saying above and approximately what Barclays is now saying – 3% on rents is about where it should be. It is not likely to decline sharply from here. And that means that getting CPI to 2% is going to depend on a collapse in goods prices or core services ex-rents, neither of which I see happening soon.
Although I should point out that core services ex-rents, aka Supercore, has been looking better of late.
As with everything else, we need to wait and see how this evolves once we get a few more months of decent data. I expect core services ex-rents to continue to decelerate a little, but that’s mainly because of Health Insurance (which fell -1.1% last month, and because of the way the Health Insurance estimate changes only once per year and gets smeared over 12 months this should work out to a drag of about 1bp/month on Core CPI). Outside of Health Insurance, the downward pressure on core services ex-rents is lessening.
And really, that’s the summary of the number: some of the effects from bad stuff (e.g. tariffs, which were never as big a deal as people treated them) are wearing off but some of the positive trends (e.g. the deceleration in rents) have also mostly run their course. The Enduring Investments Inflation Diffusion Index shows that there’s a bit of an upward trend in the distribution of accelerations/decelerations.
All of which points to the same thing I’ve been saying for a while, and that’s that once the spike was over we knew inflation would drop but it was likely to settle in the high 3s/low 4s (since amended to mid-to-high 3s). The tailwinds on inflation have turned into headwinds, so monetary policy overall needs to be tighter than it otherwise would be. The Fed doesn’t see it that way yet, and new additions to the Board of Governors are definitely more likely to be dovish than hawkish. Not only that, the federal government is also adding liquidity…or will be, if the President convinces Fannie Mae and Freddie Mac to buy $200bln in mortgages. A Federal Reserve which appreciated the inflation risks would be preparing to drain away that liquidity, no matter what it was going to do on interest rates. There’s no sign of that.
As a result: I think it’s reasonable to expect dovish outcomes from the Fed from here, although Chairman Powell will doubtless try to stick it in the eye of the President (and the American people get caught in the crossfire) before his term is up. That differs from the Fed of the last 30 years only in degree. They are going to be too loose, and there’s a good risk that inflation heads higher from here (not to 9%, mind you, but getting the sign right will matter).
Inflation Guy’s CPI Summary (November 2025)
What better way to end this crazy year than with an economic data point that we don’t know how to really interpret? Happy New Year!
Recall that, thanks to the government shutdown, the BLS released September CPI (by recalling workers to calculate the number based on data already collected) but didn’t do any of the normal price-collection procedures for the prices that are normally collected by hand. That’s far less than 100% of the index, but it’s a lot and so the October CPI was not released at all. Which brings us to today, and the November CPI – where the data was mostly collected somewhat normally. However, the calculation procedures had to be adjusted in ways we don’t really know about. You’d think that the way you do this is that you figure out the value that equates to the price level you just measured, and just say ‘hey, that’s a two-month change’ but it isn’t quite that easy. And some very smart people think this could bias the CPI lower for a few months. Whatever they end up doing, the lack of an October number is still going to mess up all the feeds (e.g. from Bloomberg) and all of the scripts and spreadsheets based on those feeds.
The BLS said in a FAQ yesterday that “November 2025 indexes were calculated by comparing November 2025 prices with October 2025 prices…BLS could not collect October 2025 reference period survey data, so survey data were carried forward to October 2025 from September 2025 in accordance with normal procedures.” In other words, November will basically be a 2-month change. (Or so we thought: see below).
Looking back to the last real data we got, in September: recall CPI was weaker than expected, but a big part of that was because of what looked like a one-off in OER. But the breadth of the basket that was accelerating was increasing, which was not a good sign. Normally the OER question would have been answered last month but…oh well.
Coming into the month…we at least have market data!
There was a big drop in short inflation swaps and breakevens this month. A lot of that is due to the steady drop in gasoline prices (see chart below), but some of it may be because sharp-penciled people anticipated that the BLS adjustment for October’s missed data is going to bias the number lower.
And boy, did it. This number is absolute garbage.
There are going to be two eras going forward: pre-shutdown inflation data and post-shutdown inflation data. Much like when there are large one-offs in the data, as in Japan years ago when there was an increase in the national sales tax rate, the year-over-year data for the next year are going to look artificially low. The BLS never adjusts the NSA data ex-post. If it’s wrong, it stays wrong. We can really hope that this doesn’t affect seasonal adjustments when the BLS calculates the new factors for next year, because that would mean next October’s CPI is going to be massively biased upwards.
Because what it looks like is that for many series the BLS didn’t calculate a two-month change based on the current price level – it looks like, especially for housing, they assumed October’s change was zero so that the two-month change reported for this month was actually a one-month change spread over two months. For example, even with the low Owners’ Equivalent Rent print in September, the y/y figure was 3.76%, so about 0.31% per month. The BLS tells us that the two-month change in OER was +0.27%. That looks more than a little suspicious to me.
Largely from that effect, core services inflation dropped from 3.5% y/y to 3.0% y/y in just two months. Riiiiight.
If in fact these two-month changes are all (or mostly) one-month changes, then the data makes a lot more sense. Either way, it’s hard to believe that the y/y change in Health Insurance dropped from 4.2% y/y to 0.57% y/y, thanks to a -2.86% decline in November from September. Yes, the Health Insurance category does not directly measure the cost of health insurance policies, and October is often when the new estimation from the BLS goes into effect, but a monthly -1.43% pre month decline for the next 12 months in Health Insurance is implausible.
Ergo, I’m not going to show most of my usual charts. This is garbage all the way down. Now, in my database instead of having a blank for October as the BLS does (for many but not all series. Seriously this is going to completely mess up any spreadsheet based on pulling data from Bloomberg), I am going to assume the price level adjusted smoothly over those two months – that is, I interpolated between September and November. That’s naïve, but it’s necessary to assume something and that’s better than assuming no change for October!
I have no idea what this will do to Median. If the Cleveland Fed follows the BLS lead, they’ll report a blank for October and a Median of something like 0.24% for the two-month period (that’s what I calculate), but it’s also garbage because garbage-in, garbage-out.
Really, this is a low point for inflation people and a low point honestly for Inflation Guy. I expected more from the BLS. I spend a lot of time defending these guys (heck, I just wrote a column on “Why Hedonic Adjustment in the CPI Shouldn’t Tick You Off”) because the staff involved in calculating the CPI are solid non-partisan professionals (aka pointy-head types) who really are trying to get as close to the ‘right’ answer as actual data allows. I can’t say that’s true in this case. Now, maybe when we get more data we will discover that the economy has abruptly shifted into something like price stability on the way to outright deflation, and it just happened to have a major inflection in October when no one was looking. But to me, it just looks like bad data.
Policymakers still gotta make policy, even if garbage data is all they have. But the correct response to not knowing what’s happening is not to assume you know what’s really happening and act accordingly – the right approach to extremely wide error bars is to do nothing. The correct approach for the Fed is to do nothing until they have another 3-6 months of data and can start getting some confidence about current trends again. That’s not the world we live in. In this world, the Fed will recognize that the inflation data is squirrelly so their behavioral response will be to ignore it and in the policy context that means that they’ll make policy for a while here based solely on the labor market. Get ready for much more market volatility around the Payrolls report again! To me, that looks like it’s likely to be an ease in two of the next three meetings, before the FOMC needs to recognize that the new inflation data is still showing 3-4% inflation. It’s possible that the Committee could take a pause while they wait for the incoming Fed Chair in May. But the inflation data will not be an impediment to an ease, and will no longer be a strong argument for holding the line if growth data looks weak.
I may be being overgenerous here. It’s also possible this will reinforce the FOMC members’ priors since many of them were utterly convinced that inflation was going to drop significantly due to housing. This, in the presence of bad data, would be a pure error. But the result is the same: an easier Fed than is healthy for the monetary system right now.
There are lots of reasons to think that yields further out the curve will stay stable or rise. But yields at the short end should probably reflect easier money going forward.
Sorry I couldn’t be more help. Here’s looking forward to 2026!
Inflation Guy’s CPI Summary (September 2025)
Well, it seems like it’s been a while since the last CPI update! Thanks to the government shutdown, it has been since this data is a week and a half later than it was scheduled to be. The importance of the CPI release is obvious, but it was reinforced by the fact it’s the only one the government is calling people back to release. It isn’t that we don’t have reasonably-accurate alternative ways to measure price pressures, though – it’s because unlike Payrolls and most other government releases that are important touchpoints for economists, the CPI is an important legal touchpoint for contracts, bonds, and legal obligations of the federal government. In this case, September’s data is a crucial number needed to calculate COLA adjustments for Social Security for next year. If this had been October’s data? I’m not sure they call back workers to release it. But that’s next month’s problem.
Speaking of next month’s problem: the government shutdown did not affect data gathering for this month’s number; they had to recall the people to collate the data and publish it but not the collectors. So the quality of the data should be fine. The data-quality question is much murkier when we look forward to next month, but since much less of the data collection is done by guys with clipboards these days, it might not be as bad as you think. Still, that will be the concern for the October CPI released next month. Like I said: next month’s problem!
Heading into the release, consensus was for +0.37% on headline CPI (SA) and +0.29% on core. I have to admit that I was confiding to people that this seemed sporty because the prior month had seen a surprising acceleration in rents that could be reversed, indications are that Used Cars would be a drag, and Food at Home also looked soft (I was right on 2 out of 3 – Food at Home was an add). That told us going in that if we were going to get to +0.29% core, either I had to be wrong on most of that or core goods ex-used cars was going to have to be pretty strong. Tariffs definitely are helping to push that narrow group of the consumption basket higher. But is that enough? Let’s see.
The backdrop going into the data was that rates have been generally softening, and the inflation swaps curve has been steepening (lessening its inversion, with near-term inflation pricing dropping more than longer-term inflation expectations). That’s consistent with a return to normalcy…but it’s really happening because energy prices have dropped quite a bit until the last couple of weeks, and that has a more immediate impact on the front of the inflation curve. The mean reversion time for energy prices is something like 15 months, so by the time you’ve gotten a few years out the curve today’s lower gasoline prices shouldn’t much affect your expectations of inflation forwards. But it affects inflation spot, which propagates through the forwards.
Actual print: SA CPI +0.31%; SA Core +0.227%. Softer than expected, and it took only a moment to see that a big part of that was due to a sharp deceleration in Owners’ Equivalent Rent (see chart). Some of that was the give-back I expected, but it was more than that and so we should put this in the back of our minds for next month – we’re probably due a reversal in the other direction over the next month or two.
Interestingly, even with the miss the Core CPI time series doesn’t look terribly weak. I mean, +0.227%, repeated for a year, still gives you 2.7% core CPI. And we won’t get downside drags from cars and housing every month.
Interesting jump in apparel this month. It’s a small category and always volatile, but since we also import almost all of our apparel it’s one place I look for tariff effects. But note the y/y numbers are still very low and in fact decelerated with this jump, implying last year’s bump in September was even larger. That’s a seasonally-adjusted figure, but I wonder if the problem here is that seasonal adjustment is failing us. Maybe pre-holiday mark-ups (from which we can show great discounts in a month!) are happening earlier. In any event it’s only 2.5% of the CPI so probably not worth too much computational cycles.
Core goods inflation rose slightly to +1.54% y/y, and core services declined to 3.47% y/y. The latter is mostly and maybe entirely due to housing, which is a core service. The former is interesting because Used Cars/Trucks was -0.41% m/m. That was expected, but it means that other core goods were more buoyant.
So here are OER and Primary Rents. 3.76% y/y (only +0.13% m/m) and 3.4% y/y (only +0.2% m/m). You can’t really tell a lot about the miss today from this chart – I showed the m/m series earlier, and the bottom line is that this continues to level out. I think the flattening is going to be more dramatic over the next 3-6 months but we’ll see. Lodging Away from Home rose again, +1.3% m/m, and is now flat y/y.
At this point, I’m thinking: with rents a downside surprise and Used Cars a downside surprise, this isn’t that bad a miss. In other words, if you’d told me we were going to get those numbers from rents and cars I would have thought core would be a lot weaker than +0.23% m/m.
Earlier I showed the last 12 Core CPIs. My guess at Median looks better, but that’s mostly because the median category is West Urban OER and even split up, an aberration in OER – and that’s what I think this is – is enough to sway Median CPI. It also means my estimate of median, +0.213% m/m, might be off because the Cleveland Fed separately estimates the seasonals for the regional OERs and so I have to guess at that part. My guess will take y/y Median CPI to 3.5% from 3.6%. And the Fed is easing. Hmm.
Here are the four-pieces charts. Food and Energy +2.99% y/y. Core Commodities +1.54%. Core Services less Rent of Shelter (Supercore) +3.37%. Rent of Shelter +3.53%. These are the four pieces that add up to CPI. None of them looks terrible except for Core Goods, and there’s limited upside to that – and it has a short period, so in a year it’s likely to be lower. I do think that going forward, core goods remains positive instead of the steady deflation it was in for decades, but not big positive. However, you need it to be negative if you want inflation at 2%, unless you get core-services-ex-rents a lot lower (but that’s highly wage-driven, and reversing illegal immigration helps support that piece somewhat) or rent of shelter a lot lower. The latter is certainly receding but it’s not going to go a lot lower.
I don’t usually spend a lot of time talking about energy, because that’s a hedgeable piece (largely – gasoline is a big part of energy and that’s easy to hedge with a little lag; electricity is harder). This month, Energy was +0.12% NSA. But next month, we’ll see a decent drag because of the sharp drop in gasoline over the last few weeks. That’s a little early compared to the usual seasonal, and it may mean we get the usual December drop in gasoline in October CPI.
Except…that I think the White House has teased that we might not get October CPI at all, just skip it, because of the difficulty gathering data. If that is true, the fallback mechanisms will kick in. See my piece on what that means, here, but the bigger point is that you wouldn’t get my scintillating commentary. I guess again that’s not this month’s problem.
Now, I have to show this almost by habit, and because the economists expecting housing deflation will be dancing in the streets. Take pictures, and show them again next year. They never learn. Housing inflation is slowing but there is no sign rents are going to come anywhere near deflation. Except maybe on a weighted basis if Mamdani gets elected Mayor of New York City and freezes rents. But then we’ll have to start looking rents ex-NYC.
How disinflationary a period are we in? Wellllll…of the item categories in the median CPI calculation, there were zero core categories that decelerated faster than 10% annualized over the last month (-0.833% or faster). On the plus side, there were Personal Care Services (+11.9% m/m annualized), Footwear (+12.0%), Motor Vehicle Fees (+14.2%), Tenants’ and Household Insurance (+15.2%), Lodging Away from Home (+17.5%), Miscellaneous Personal Goods (+17.9%), Men’s and Boys’ Apparel (+19.3%), and Public Transportation (+21.5%). These are small categories for the most part – but not all import goods and interesting in that the tails are all to the upside. That’s not the way a disinflationary economy usually looks, although I don’t want to overstate the importance of a single month!
Here’s the observation about long tails compressed into a single number, the Enduring Investments’ Inflation Diffusion Index. It’s signaling upward pressure.
Below is a chart of the overall distribution. The two big spikes in the middle are mainly rents and OER. But take those away and you can see there’s not a lot of categories in the 1-3% range, and a decent weight in the 5-6% range. This doesn’t really look like a price system settling back down placidly to 2%.
Now, the stock market clearly loves this, which makes sense. The Fed is going to ease, probably twice more this year. But that was already baked into the cake in my mind, because the Fed no longer targets 2% inflation. Remember that in the most-recent change to the 5-year operating framework the Fed, in Chairman Powell’s words, “…returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.” I talk more about that here: https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/ Ergo, the Fed doesn’t really care if we get to 2%. They’d prefer to not see inflation head higher, but they can spin a story to themselves that even though median inflation is in the mid-to-high 3s, “the process of inflation anchoring is underway” or somesuch nonsense. As long as it’s not hitting them in the face that inflation is going up, they’ll keep relying on their models that say it should be going down. N.b., those are the same models that said inflation shouldn’t have gone up that much to begin with, and should have been transitory, but we all know “Ph.D.” stands for “Pile it higher and Deeper.”
Eventually, inflation going up probably will hit them in the face. But that’s such a 2026 problem.
The Fault, Dear Brutus, is in R*
I want to say something briefly about the “neutral rate of interest,” which has recently become grist for financial television because of new Trump-appointed Fed Governor Stephen Miran’s speech a couple of days ago in which he opined that the neutral rate of interest is much lower than the Fed believes it is, and that therefore the Fed funds target should be more like 2%-2.25% right now instead of 4.25%.
Cue the usual media clowns screaming that this is evidence of how Trump appointees do not properly respect the academic work of their presumed betters.
If that was all this is, then I would wholeheartedly support Miran’s suggestion. Most of the academic work in monetary finance is just plain wrong, or worse it’s the wrong answer to the wrong question being asked. And that’s what we have here. Anyone who thinks that Miran is an economic-denialist should read the speech. It is mostly a well-reasoned argument about all the reasons that the neutral rate may be lower now than it has been in the past. And I applaud him when he comments “I don’t want to imply more precision than I think it possible in economics.” Indeed, if we were to be honest about the degree of precision with which we measure the economy in real time and the precision of the models (even assuming they’re parameterized properly, which is questionable), the Fed would almost never be able to decisively reject the null hypothesis that nothing important has changed and therefore no rate change is required!
I can’t say that I agree with Miran’s argument though. Not because it’s wrong, but because it’s completely irrelevant.
Sometimes I think that geeks with their models is just another form of ‘boys with their toys.’ And that is what is happening here. The “neutral rate of interest” is a concept that is cousin to NAIRU, the non-accelerating-inflation rate of unemployment. The neutral rate, often called ‘r-star’ r* (which is your clue that we’re arguing about models), is the theoretical interest rate that represents perfect balance, where the economy will neither tend to generate inflation, nor tend to generate unemployment. Like I said, it’s just like NAIRU which is a level of unemployment below which inflation accelerates. And they have something else in common: they are totally unobservable.
Now, lots of things are unobservable. For example, gravity is unobservable. Yet we have a very precise estimate of the gravitational constant[1] because we can make lots of really precise measurements and work it out. Economists would love for you to think that what they’re doing with r* is similar to calibrating our estimate of the gravitational constant. It’s not remotely similar, for (at least) two enormous reasons:
- Measuring the gravitational constant is only possible because we know (as much as anything can be known) what the formula is that we are calibrating. Fg=Gm1m2/r2. So all we have to do is measure the masses, measure the distance between the centers of gravity, and infer the force from something else.[2] Then we can back into G, the gravitational constant. Here’s the thing. The theory of how interest rates affect inflation and growth, despite being ensconced in literally-weighty economics tomes, is just a theory. Actually, several different theories. And, by the way, a theory with a terrible record of actually working. To calibrate r*, the hand-waving that is being done is ‘assume that interest rates affect the economy through a James and Bartles equilibrium…’ or something like that. It is an assumption that we shouldn’t accept. And if we don’t accept it, calibrating r* is just masturbation via mathematics.[3]
- With the gravitational constant, every subsequent measurement and experiment confirms the original measurement. Every use of the model and the constant in real life, say by sending a spacecraft slingshotting around Jupiter to visit Pluto, works with ridiculous precision. On the other hand, r* has approximately a zero percent success rate in forecasting actual outcomes with anything like useful precision, and every person who measures r* gets something totally different. And r* – if it is even a real thing, which I don’t think it is – evidently moves all the time, and no one knows how. Which is Miran’s point, but the upshot is really that monetary economists should stop pretending that they know what they’re doing.
In short, we are arguing about an unmeasurable mental construct that has no useful track record of success, and we are using that mental construct to argue about whether policy rates should be at 2% or 4%. Actually, even worse, Miran says that the market rate he looks at is the 5y, 5y forward real interest rate extracted from TIPS. The Fed has nothing to do with that rate. But if that’s what he is looking at why are we arguing about overnight rates?
I should say that if there is such a thing as a ‘neutral rate’ that neither stimulates nor dampens output and inflation, I would prefer to get there by first principles. It makes sense to me that the neutral long-term real rate should be something like the long-run real growth rate of the economy. And if that’s true, then Miran is probably at least directionally accurate because as our working population levels off and shrinks, the economy’s natural growth rate declines (unless productivity conveniently surges) since output is just the product of the number of hours worked times the output per hour. But I can’t imagine that the economy ‘cares’ (if I may anthropomorphize the economy) about a 1% change in the long-run real or nominal interest rate, at least on any time scale that a monetary policymaker can operate at.
The best answer here is that whether Miran is right or not, the Fed should just pick a level of interest rates…I’m good with 3-4% at the short end…and then change its meeting schedule to once every other year.
[1] Which may in fact not be constant, but that’s a topic for someone else’s blog.
[2] In the first experiment to measure gravity, which yours truly replicated for a science fair project in high school, Henry Cavendish in 1797 figured the force in this equation by measuring the torsion force exerted by the string from which his two-mass barbell was suspended, with one of those masses attracted to another nearby mass.
[3] Yeah, I said it.
Inflation Guy’s CPI Summary (August 2025)
Before I begin talking about today’s CPI, a quick word about the 24th anniversary of the terrorist attacks of 9/11. As someone who worked 1 block from the Towers, I can tell you it’s a day I will never forget and filled with images I can never erase. But I also remember that in the weeks that followed, the country was unified in a way I’d never seen. Rudy Giuliani was “America’s Mayor” for his courage and steady hand during the disaster and in the period that followed. When I traveled to the Midwest, menus were filled with ‘Freedom Fries’ and strangers asked with concern about my family and friends when they heard I was from New York. It seems crazy to me that only 24 years removed from that, the country is divided in a way I’ve never seen. Everyone said “we will never forget.” And then they forgot.
But I do not forget. I give prayers and thanks for the brave first responders I saw that day and for the families of those who didn’t return. And you should too.
All of which makes the monthly CPI report seem very small. In truth, it is small all of a sudden. From being one of the most-important releases for a couple of years because of the Fed’s assumed reaction function, it has abruptly been pushed to the back. This is partly because of the weak Employment data and the massive downward revisions to the prior data but that point is reinforced by the Fed’s recent adjustment to the inflation targeting framework, in which they removed any imperative to make up for periods of high inflation by engineering lower inflation so that the reaction function is basically one way. (See my writeup on this at https://inflationguy.blog/2025/09/02/the-fate-of-fait-was-fated/.) I guess there’s an ironic parallelism here. After the inflationary 1970s and the pain of bringing inflation back down, the Fed said “we will never forget.” And then they forgot.
But I do not forget. And neither should you. An investor’s nominal returns are irrelevant (except to the IRS). What matters is real returns, and a period of higher and less-stable inflation has historically resulted in lower asset prices since the most important indicator of future returns over normal investing horizons is starting price. If markets need to adjust to higher inflation to give higher nominal returns, the easiest way to do that is to lower the starting price. So whether the Fed cares, we should.
And with that – we came into today with real yields having fallen some 20bps this month, but with inflation expectations having not declined much at all. Obviously, that’s the market’s reaction to the presumed tilt of the Fed.
The CPI report was slightly above expectations, which were already somewhat higher than in prior months. So when people tell you this was a ‘small miss higher,’ that’s mainly because economists adjusted their expectations, not because the number was similar to prior months. Month/month headline inflation (seasonally adjusted) was +0.382% (expectations were +0.33%), with core at +0.346% (expectations were +0.31%). Markets have not reacted poorly to this figure, but I wonder if core had been slightly higher and rounded to +0.4% if we’d have seen more introspection.
But as I said, this is a ‘small miss’ but that does not mean it was a small number. Indeed, with the exception of the jump in January associated with tariff noise, this is the highest core figure in 17 months.
There were a number of upside categories, but one of them was not Medical Care. Some people had been looking for a move higher here, and Doctor’s Services rose a bit, but Medicinal Drugs fell -0.372% m/m and is now down year/year. That surprises me, but there are a lot of pressures on the drug industry right now and it is going to take a while to see how it shakes out.
Core goods prices continued to accelerate. On a y/y basis, core goods are +1.54%. With the exception of the COVID spike, this is the highest level of core goods inflation since 2012. Some of that is definitely due to tariffs, and that will trickle in for a while. But the long-wave concern is that deglobalization/re-onshoring of production means that it will be very hard to get core goods inflation back to the persistent mild deflation we had enjoyed for a very long time. And without that, it is very hard to get core inflation to 2%, especially if core services (+3.59% y/y) stops improving as the chart sort of hints it might.
One surprise you will hear a lot about is Owners Equivalent Rent, which was +0.38% m/m. Primary Rents were +0.30% m/m. Both of those are higher than the recent figures, but this looks like some residual seasonal-adjustment issues to me. The y/y for both continues to decline, albeit at a slowing rate, which means that the number we dropped off from last year was higher than the upside surprise of today.
Rents are on schedule.
We also saw another jump from airfares, +5.87% m/m, and Lodging Away from Home (+2.92% m/m) finally rebounded after months of weakness. Used cars were +1.04% m/m, and new cars +0.28%. When you look at all of the pieces, it adds up to Median CPI being almost the same as last month: my early guess is +0.276% m/m.
Turn that picture any way you want to. I don’t see a downtrend.
When we break down inflation into the four main pieces, none of them is in deflation and none seems to be an overt drag or pulling everything else up. Food and Energy is +2.16% y/y. Core goods is +1.54% y/y. Core services less rents (aka Supercore, chart below) is +3.56% y/y. And Rent of Shelter is +3.61%. How do you want to get inflation to 2% from those pieces?
Long-time readers will know this does not surprise me. Median CPI will be around 3.6% y/y again. That’s where we are. We overshot my ‘high 3s, low 4s’ target to the downside a bit, but we’re back up in the mid-to-high 3s. I’ll take that as a win.
I want to share the money supply chart. On an annualized basis, we’re near 6% y/y over the last six months. That is back to pre-COVID levels, and is too fast in this environment. You can’t get 2% inflation with deglobalization and sour demographics if you’re running the monetary playbook from when you had globalization and positive or neutral demographics.
And finally, we now know USDi’s price through the end of October.
So what does all of this mean for policy? Well, see what I said above about inflation targeting and the change of the Fed’s operating framework. The most important things to the FOMC right now are, in order:
- Employment
- Politics, and jockeying for position to be named next Fed Chair
- Internal modeling about tariffs, inflation expectations, rents, etc.
- Actual inflation numbers, like CPI
35th or so in importance is “the quantity of money,” if it’s on the list at all. You can probably glean from my list that I think the Fed is likely to ease. Let me make clear that I do not think that a wise Fed chair would even consider easing with median inflation steadying around 3.6%, and a 50bps cut would be laughable. However, this is not a wise Fed chairman, and this one is going to ease. In my gut, I think the Fed will cut 25bps but with several dissents for 50bps. I would not be shocked with a 50bps ease even though it is completely boneheaded to do it with inflation still running hot with no clear path for it to decline to what used to be the target.
But that’s the point I suppose. Is there even a target, if the Fed doesn’t mind missing it?
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable or flatcoins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where many of these charts are also posted shortly after CPI just as I used to do on Twitter.
The Fate of FAIT was Fated
Growth in the US is ebbing, and it is likely only the AI boom that is keeping us from recording a small recession. Unemployment is still rising, although slowly, and credit delinquencies are rising. Because the services sector and the goods sector are still asynchronous – a holdover from the COVID period – we haven’t seen an aggregate contraction, but it will happen eventually. That doesn’t concern me. Recessions happen. It is only worrisome because equity markets are so ‘fully valued’ that an adjustment to a recession could be rough. On the other hand, all signs point to the Federal Reserve starting to ease, and this may support stocks. I would go so far as to say that investors are counting on that.
That is a rather ordinary problem. The bigger problem has not yet been realized by equity markets, but as we look at long maturities on the yield curve we see that yields are near the highs of the year even with the Fed expected to ease. That is not normal. When the Fed eases the curve tends to steepen, because however long the period of lower short rates, it will be a larger proportion of a shorter-maturity instrument. But long rates still decline in that case, normally.
You can insert your favorite story here, about how foreign investors hate Trump, or people are worried about inflation, or the credit profile of the United States. My preferred explanation (see “The Twin Deficits – One Out of Two IS Bad”) is that if you reduce the trade deficit sharply but do not reduce the budget deficit equally sharply, then the balance must be made up by domestic savers and that implies a higher rate of interest.
There’s also some reason to be wary of the turn higher in inflation, even though that was entirely foreseen (see “Ep. 145: Beware the Coming Inflation Bounce”) and a good part due to base effects. There are, though, some signs of underlying secular rather than cyclical pressures on prices. For example thanks partly to AI electricity prices started accelerating higher in 2021 but unlike other parts of the CPI have continued to rise. The CPI for Electricity stands 35% above the level of year-end 2020, and well beyond the long-term trend. Beef prices are 41% higher and still rising.
Of course, there are always prices that are rising but there are two reasons I am more concerned about this now. The first is that the money supply has returned to a positive and rising growth rate and is at a level inconsistent with long-term price stability even before the Fed renews its easing campaign.
Five percent was once a nice level for M2 growth, when demographics and globalization were following winds. Now they are headwinds and we need to be lower. Still, I wouldn’t get panicky about 5%. Get to 8% and I’ll be more concerned. But the reason that might happen concerns changes happening at the central bank.
What gets the headlines is the continual pressure that the Trump Administration is putting on Fed Chairman Powell and others on the Federal Reserve Board, several of whom are jockeying to be dovish enough to be selected as the next Fed Chair. But the much more important development was the 5-year review of the Fed’s operating framework, which Powell discussed at his Jackson Hole speech. The significance of this was seeming lost on most investors, although 10-year breakevens have gradually risen and are up at 2.42%, and other than in the post-COVID surge they’ve not been much higher than that since 2012 or so.
These are 10-year breakevens, so this isn’t a tariff effect. What’s going on here? Not much, yet, but…there is the change in the Fed’s framework, which I think is important.
Five years ago, the Fed abandoned a specific inflation target in favor of “Flexible Average Inflation Targeting”, or FAIT, which basically said “we are targeting 2% inflation, but only over time. So when inflation is too low for a while, then it’s okay to let it run hot for a while later.” At the time, this was a clear sign that monetarists – who don’t necessarily believe there is a tradeoff between inflation and growth like the Keynesians do – were losing the battle. More flexibility to respond to inflation ‘tactically’ is not something that we needed, and it wasn’t clear how that would be a helpful change anyway.
But the current 5-year framework adjustment is worse. It basically abandoned the good part of FAIT, which was any kind of soft commitment to be hawkish in the future if necessary. In Powell’s words – and I’m not making this up – “…we returned to a framework of flexible inflation targeting and eliminated the ‘makeup’ strategy.”
Yep, that’s what he said.
There is a lot more in Powell’s explanation, but most of it all leans in the same direction. For all my historical criticism of former Chairman Greenspan, he deserves credit for this: he used to say that achieving low and stable inflation was key to achieving maximum stable employment over time. Thus, inflation was primary, not secondary, in achieving the dual mandate. Now, the Fed ostensibly wants to target a low level of inflation…because that’s what central banks are supposed to do…but recognizes that sometimes they’ll want to emphasize lower rates to help Employment – and the important part is that as I just noted, they won’t ‘make up’ for running too much liquidity now by running less liquidity later. Does anyone want to take the other side of the bet that the Fed will have an easier time lowering rates and keeping them low, than raising them and keeping them high? Accordingly, the long-term inflation outlook just got worse. I don’t think we are returning to the 1970s, but we aren’t returning to 2% any time soon – and the Fed is okay with that!
FAIT was never a very good idea, and I didn’t think it would survive the first time inflation ran too high and dictated an extended period of very tight money. It didn’t. I didn’t think they’d actively make it worse, and maybe the joke’s on me. They always make it worse.
Inflation Guy’s CPI Summary (July 2025)
The inflation story and the employment story are about the only things rippling the still summer waters these days, it seems. The weak employment data in the most-recent report got equity investors very excited since every analyst worth his or her salt believes that lower rates are good for the companies he/she covers, but those companies will surely be able to avoid losing business in an economic slowdown. And, to be fair, because the goods and services sectors in the US (and global) economy are out-of-sync, any recession is likely to be fairly shallow (and being out-of-sync is probably why the recession has been so delayed – different sectors are having recessions at different times. I discussed this in last week’s podcast, Ep. 147: Out of Sync).
But the fly in the ointment would be if inflation heads higher, wouldn’t it?
Well, maybe not so much. In normal times, probably. But in today’s world there is a nice, built-in excuse for any inflation uptick: it’s the tariff effect! It is amazing how focused on tariffs everybody has been, when they forecast/analyze the CPI report. The core goods sector of the economy is about one-fifth of total consumption. Tariffs will (and finally are) driving this higher, but that story will eventually pass. Core goods will not be what keeps inflation high or sends it higher in 2026. But you know why everyone wants to focus on it? Because if you can blame the inflation uptick on tariffs, then you can argue that rate cuts still make sense. More on that later, but when you look at the monthly changes in real yields and inflation expectations you can see what is happening: yields are down, inflation expectations basically unchanged, over the last month. The best of all worlds!
Which brings us to today’s report. The consensus expectations were for +0.23% on headline CPI (seasonally-adjusted), +0.29% on core, pushing the y/y figures higher for both of them as we drop off soft data from last summer. The actual prints were +0.197% on headline (yay!) and +0.322% on core (boo!). That was the highest m/m core inflation figure since January, and the first time since then that core has been higher than consensus expectations. It also was the highest m/m core number, other than January’s tariff-related spike, since March 2024.
The category breakdown was interesting for a change because the top culprits were Medical Care, Recreation, and Other.
To be fair, housing would have contributed more except for another drop in Lodging Away from Home. Seasonally-adjusted prices for lodging away from home have now fallen 7.3% since January. I have been working on the assumption that this is a deportations story, or possibly a tourism story (I don’t really think ‘foreigners aren’t visiting the US because they hate Trump’ is really happening but in some quarters that’s the story they’re selling). But if you look at this chart and notice the times that hotel prices declined meaningfully, there’s an argument that it’s a recession story. Or that it could be, if it continues to slide.
Primary rents accelerated slightly m/m, +0.26% vs 0.23% last month, but Owners’ Equivalent Rent decelerated to +0.28% vs 0.30%. Both are playing to form, but it’s worth keeping an eye on Primary Rents here. Deportations as an inflation story would show up in Lodging Away from Home but it also could show up eventually in rents – but a recession wouldn’t be expected have any meaningful impact on rents. So how those two series behave might give us a clue. Or maybe not; perhaps I’m trying to read too much into this.
Core goods accelerated again. The bounce was totally expected, but now that we are over +1% (+1.17% y/y) we are clearly seeing some of the impact of tariffs. Core services is more interesting, though. Even with rents decelerating and Lodging Away from Home dropping again, Core services ticked higher.
Indeed, lumping core services and core goods together, but taking out shelter, and we can see that the underlying core dynamic looks like it had been bottoming anyway and might be heading higher.
A large jump in airfares (+4.04% m/m) is partly to blame this month…but in March airfares were -5.3% m/m and the worst since 2021 while today’s number was the highest since 2022. Since COVID, airfares have just been really unstable, or the seasonals have been unstable, or both. I am not worrying too much about this jump.
Airline fares are 0.9% of CPI, but this volatility has added to the overall volatility of the CPI. And before you say ‘this is a consequence of resource constraints at the BLS!’ you should realize that airfares are not collected by people with clipboards but by web scrapers. However this is yet another reminder that Median CPI is a better way to look the overall trend, so as not to be distracted by little categories. My early guess at Median this month is +0.276%, a bit better than last month. But there is nothing here that looks to me like a moderating trend to lower inflation.
In fact, median y/y ought to tick higher again this month to about 3.65%. It is stabilizing in the high-3s. The next few monthly figures to drop off will be 0.3s, so I don’t think we will see median y/y head back to the 4% level. But having said that, there is one development that bears watching.
Core services less rent-of-shelter, aka “Supercore”, rose +0.48% m/m. If higher tariffs and deportations lead to more domestic employment and higher wages – which they should, but it isn’t yet really in the data as employment looked weak and the Wage Growth Tracker ticked down to +4.1% y/y this month – then this part is what will keep inflation uncomfortably high even if rents continue to decline (I don’t see them declining lots further than this) and goods inflation eventually declines after the tariff effect passes through. That isn’t today’s story. But it might be a 2026 story. Stay tuned. At the tails of the distribution this month we had greater than -10% annualized monthly inflation from three non-core categories while greater than +10% from eight non-core categories – including motor vehicle parts and equipment and miscellaneous personal goods, which are tariff stories, but also tenants and household insurance, miscellaneous personal services, public transportation, and motor vehicle maintenance and repair. Those are all service stories. As is this one, although it’s also a goods story indirectly (I explain further in the Q3 Quarterly Inflation Outlook, due out tomorrow – subscribe at https://inflationguy.blog/shop).
Overall, the underlying trend is the same: we’re settling in the high-3s for median inflation. Last month, I said that unless the economy starts to soften more seriously there just isn’t a good argument right now for rate cuts and the optics of rising year/year inflation would make it more challenging for the FOMC to consider an ease. That is still true. If Fed credibility matters to inflation, then inflation should start heading up because we are clearly getting more doves. If tariffs matter, inflation should be heading up because the tariffs are now showing and will be an effect for a while. If money growth matters, inflation should be heading up because M2 growth is back to +4.5% and accelerating.
But the core question is whether the Fed cares about inflation right now. Listening to their public statements, it doesn’t appear they do. One might argue that they are just supremely confident that if the Unemployment Rate heads higher, inflation will head lower so they have some room to move. To be honest, “supremely confident” and “Fed official” are not phrases that should appear in the same paragraph except sardonically. Nevertheless, the Fed is likely to ease soon, and likely multiple times before the end of the year.
And they’re worried that President Trump is going to hurt Fed credibility! That’s a little like the streetwalker who is afraid that this skirt is going to make her look cheap. Honey, that ship has sailed.
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Inflation Guy’s CPI Summary (April 2025)
Before the CPI analysis, I always try to give some context for where we are in the ‘story’ about the evolution of inflation right now. It’s really difficult to do that, though, because of all of the massive policy changes that are happening – and often in opposite directions with respect to the effect on inflation. Here is the Baker, Bloom & Davis Economic Policy Uncertainty Index, which is derived by scraping news sources. Even strong supporters of President Trump’s have to admit that his Administration has been a whirlwind on economic policy (for many of them, of course, that’s a feature and not a bug).
Here goes, anyway. Remember that last month, core CPI crashed but Median CPI actually accelerated. This kept us from actively celebrating the great inflation news; we knew that the good news was concentrated in a few one offs. In particular, Airfares (-5.3% for March), Lodging Away from Home (-3.5%), Used Cars (-0.69%), Car and Truck Rental (-2.66%), and Medicinal Drugs (-1.30%). But, as Median showed last month, there was really no reason to think that inflation was behind us…even before any effect from tariffs.
Speaking of tariffs, prior to this month we hadn’t really expected to see any effect yet and most economists thought that we shouldn’t see that much impact in the April figures either since the big tariffs on everyone went into place early in that month. However, remember that Mexico, Canada, and China had all faced escalating tariffs prior to April, so if there is going to be an impact we should expect to see something soon. I don’t expect a lot in most categories, but some impact in a few. It will be hard to discern how much of any monthly price change is tariffs, of course. We will look at Apparel, where demand elasticity in the short run is not terribly low. Broadly, though, remember that demand elasticity and foreign content percentage are both important…and foreign content in most goods is pretty low. I’d also look to Medicinal Drugs, since a lot of APIs are China-sourced and the demand for many drugs is pretty inelastic in the short-run, but I didn’t expect a lot of impact there (pharma companies will have had inventories), and going forward it will be muddied by Trump’s announcement of the Most-Favored-Nation policy in pharmaceuticals.
Speaking of that announcement, this month’s review of changes in inflation swap levels is seriously polluted because that announcement combined with the 90-day pause on China tariffs caused a massive crash in 1-year inflation expectations.
Despite the drop in tariff rates on China (for now), remember average tariffs remain the highest since the Great Depression (ominous music)! Of course, back then the US was a significant net exporter, so reciprocal tariffs were a bigger problem. Imports were only about 2-3% of GDP.
(Chart above is from https://www.stlouisfed.org/on-the-economy/2019/may/historical-u-s-trade-deficits)
(Chart above is from https://www.stlouisfed.org/on-the-economy/2020/march/evolution-total-trade-us)
There you go. That’s the context. Now onto the number.
CPI for April was expected to be +0.25%, and +0.27% on Core. The actual prints were 0.221% and 0.237%, respectively, so a mild surprise lower (although it turned the +0.3%/+0.3% rounded expectations to +0.2%/+0.2%, looking more dramatic a surprise than it actually was). Core is right about where it has been for the last 6 and 12 months (0.244% and 0.229% average, respectively) with the big January spike and the March plunge basically offsetting each other.
Amazingly, of the eight major subgroups only Housing, Medical Care, and “Other” increased on a m/m basis. What is especially surprising in that light is that Apparel – where the tariff canary in the coal mine lives – was down on the month.
Core goods continues to hook higher, now at +0.13% y/y. Remember, this is before any tariff effect has really been felt. In my mind, this is more the underlying ‘deglobalization’ effect: as I’ve said for a while, the deep deflation in core goods that we saw was a partial retracement of the COVID spike and we should expect going forward to see a small positive inflation in goods. Core services is decelerating nicely, and it will need to continue to do that if we’re ever going to see downward pressure in median inflation from where we are now.
Speaking of Median CPI, my early estimate is +0.308% m/m, putting the y/y at 3.43%. That’s about where we’ve been, and where we’re likely to be going forward.
Looking at some of those one-off categories from last month, Airfares fell another -2.83% m/m after that -5.3% prior decline. Some of that is jet fuel, some is tourism I suspect. Lodging Away from Home went flat (-0.1% m/m) from -3.54% prior. I think we’ll see continued downward pressure in that category, as hotels in some big cities are gradually emptied of illegal migrants and get added back to the stock of available rooms, but March’s drop was just too big. Used Cars’ decline (-0.53%) surprised some people, because the private surveys showed that prices advanced last month, but the seasonal assumption was a decent hurdle this month that wasn’t cleared. However, if you were worried about how the spike in car parts tariffs would cause car prices to spike…because that’s what the news was hyperventilating about…you needn’t have. New Car prices were also slightly down, -0.01% compared to +0.1% last month.
As for shelter, it continues to flatten out, with Primary Rents 3.98% y/y and OER at 4.31% y/y. Actually, Primary Rents were flat on a y/y basis compared to the prior month, and have basically converged with our model, which is around 3.7%. From here we should expect very slow deceleration, but rents should stay above 3.25% or so on a y/y basis.
Supercore is looking great. This is about the best news in the report, because if Shelter is just about tapped out and Core Goods is trending just above zero we’d need Core Services to continue to dive.
That’s the good news. The bad news is that the spread of median wages over median prices has returned to its long-run average, which means that it will be hard to see additional sharp declines here…it isn’t going to come from squeezing wages further.
Outright, the Atlanta Fed Wage Growth Tracker – the best measure of wages in my opinion – is at 4.3% y/y. That’s right where it was in November. It’s going to be very hard to squeeze services prices lower if wages don’t decelerate further.
Finally, let’s circle back to pharmaceuticals. I’m going to point you again to my article from 2020, which is the first time that the President mooted the idea of a Most-Favored-Nation clause affecting the pharmaceutical industry. https://inflationguy.blog/2020/08/25/drug-prices-and-most-favored-nation-clauses-considerations/ The upshot is that even if the MFN policy takes place exactly as the President states, retail drug prices are unlikely to decrease anything like as much as he has said. In fact, there could even be some circumstances in which drug prices rise because companies stop selling in foreign countries at levels lower than in the US (because they face a more-elastic demand there) but which contribute to the total profit of the drug company. There may be others in which the drug company stops selling the drug at all in the US. Furthermore, drug prices overall have only risen 7% since pre-COVID, compared to 23% for core prices generally (the black line in the chart below is the overall CPI for Medicinal Drugs; the blue is the core CPI price level – both normalized to December 2019).
By the way, if I was concerned about importing APIs from China and wanted the US to start producing more of them, I don’t think I’d be trying to crush end-product prices and reduce the incentive to spin up production of the APIs. So there will be a lot of exceptions to the MFN policy, and you can tell from the performance of pharma companies yesterday after the news (big up with the market, not down!) that investors don’t expect any important impact on the bottom lines of pharmaceutical companies. I agree. I think Medicinal Drugs going forward will probably decline a bit for some celebrated cases, but not in a big way that pushes CPI lower significantly.
The big conclusion here is that inflation continues to run at about 3.5% or so (Median), and there is no sign of a significant further deceleration to come. As long-time readers know, this has been my theme for a couple of years, that we will end up in the ‘high 3s, low 4s’ on median inflation, because the overall backdrop of deglobalization and demographics argue for a higher floor. If the Fed keeps money growth very low, my opinion could change (and I’d already amend my target to ‘mid to high 3s’ as the mode), but I am not very optimistic on that.
However, I also don’t think there is anything about the inflation picture that argues the Fed has a lot of room to drop rates significantly. I said last month “The right answer to uncertainty from a policymaker perspective is to increase the hurdle for taking action. The right answer is to make no changes to policy. I am not confident that the Federal Reserve will correctly separate the ‘price of risk’ effect from the ‘economic growth’ effect. They are correct to note that tariffs by themselves are not inflationary in that they are one-off effects. If they believe that, and they think there’s a big recession coming, they’ll cut rates. That would be a mistake, especially given the uncertainty.” I still think that’s the case. At the moment, there is no reason to cut rates any further than the ‘let’s help Biden’ cuts did, except to appease the President and I see little urgency from this Fed to do that. I wouldn’t expect any big moves from the Committee, any time soon.
One final announcement. If you’re an investor in cryptocurrencies (in particular, stable coins) and have a Telegram account, consider joining the read-only USDi_Coin room https://t.me/USDi_Coin where the USDi Coin price is updated every four hours or so…and where these charts are also posted shortly after CPI just as I used to do on Twitter before they changed the API to make auto-tweeting charts very difficult.
